Assignment: Chap7_HW_CNOW 1. Blueprint Problem: Perpetual Average Cost Inventory Valuation Basics Income measurement and asset valuation are two concepts at the core of accounting....

Inventory Valuation Basics

Income measurement and asset valuation are two concepts at the core of accounting. Recall that the matching principle requires that costs incurred to generate revenue should be recognized in the same period that the revenue is earned. For most merchandising companies, the cost and control of inventory is the focal point of the operation. Inventory valuation applies to many companies. Thinking about this lesson, choose which companies below might benefit from inventory valuation.

Inventory Systems and Costing Methods

Inventory systems and inventory costing methods must be understood for proper inventory valuation and measurement. The two basic systems of accounting for merchandise inventory are the perpetual inventory system and the periodic inventory system. Under the perpetual inventory system, continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold. Under the periodic inventory system, the inventory not yet sold, or on hand, is counted periodically. This physical count is usually taken at the end of the accounting period.

What type of inventory tracking system is in use when changes in inventory are immediately displayed on the balance sheet?
  _________________  

"Goods Flow" versus "Cost Flow"

Different valuation methods produce significantly different values for cost of merchandise sold and subsequent inventory levels. This means that the choice of inventory valuation method can have a significant effect on a company's financial position.

Although the implications are far reaching, the two items most directly and immediately affected by the choice of inventory valuation method are cost of merchandise sold on the   _________________   and inventory on the   _________________   .

The following formula illustrates the relationship between the cost of merchandise sold and the ending inventory. The part of the cost of merchandise available for sale is allocated to the cost of merchandise sold for the inventory that is sold and the value of the unsold inventory is assigned to the ending inventory. Therefore, a change in the amount of the cost of merchandise will impact the value of the ending inventory.

How would an inventory valuation method that results in higher cost of merchandise sold for the current period affect the following items?

Choosing a Valuation Method

There are four costing methods: specific identification; first-in, first-out (FIFO); last-in, first-out (LIFO); and average cost. To better understand the average cost method, imagine beginning inventory and each purchase as separate layers. These layers determine the cost of merchandise available for sale. A physical inventory is taken, and cost of goods available for sale is then allocated to cost of merchandise sold and ending inventory.

Imagine that you are an external consultant for Portsmouth Co., a company trying to determine the most appropriate inventory valuation method for its operations. Its cost of inventory has been fluctuating up and down all year, so Portsmouth Co.'s primary goals are to minimize the effects of the cost fluctuations on its figures for cost of merchandise sold, without spending too much money. The available options are FIFO , LIFO , average cost, and specific identification.

Given Portsmouth Co.'s unique needs, which method would you recommend?
  _________________  

Applying Average Cost

You will now put the average cost method into practice. Portsmouth Co. would like to explore what is meant by the weighted average cost per unit, a concept that is central to this method of inventory valuation. Remember, the weighted average must be adjusted with each purchase. Also, as sales occur, previous inventory values must be bundled to keep track of inventory on hand and to accurately track subsequent additions to inventory.

Inventory and Cost of Merchandise Sold

Asset valuation and income measurement are two of the most fundamental accounting concepts. For any company that sells goods, inventory is a main focus. This problem concentrates on perpetual FIFO inventory valuation.

When a company sells inventory, an expense is recorded. Which of the following facts regarding this statement are true?

When a company purchases inventory, it is immediately displayed on the   _________________   as   _________________  

The amount at which inventory is recorded is based upon the   _________________   .

Inventory Systems and Costing Methods

There are two concepts that must be understood for inventory valuation and measurement: inventory systems and inventory costing methods. The two basic systems of accounting for merchandise inventory are the perpetual inventory system and the periodic inventory system. Under the perpetual inventory system, continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold. Under the periodic inventory system, the inventory not yet sold, or on hand, is counted periodically. This physical count is usually taken at the end of the accounting period.

What type of inventory tracking system is in use when changes in inventory are immediately displayed on the balance sheet?
  _________________  

"Goods Flow" versus "Cost Flow"

First-in, First-out (FIFO)

There are four costing methods: specific identification; first-in, first-out (FIFO); last-in, first-out (LIFO); and average cost. This example will focus on FIFO. Under the first-in, first-out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold and the ending inventory is made up of the most current purchases.

To better understand the FIFO method, imagine that beginning inventory and each purchase is a separate layer. These layers determine the cost of goods available for sale. For each sale, start with the earliest purchase (which may be beginning inventory) and work forward until you have accounted for the units sold.

Using FIFO, we assume the costs of the   _________________   items we purchased are assigned to the first items we sell. Therefore, the the most recent costs are assigned to the   _________________   while the   _________________   will consists of costs the beginning inventory and earlier purchases.

According to GAAP, there are three acceptable ways in which a publicly traded company may value inventory. They are FIFO, LIFO, and average cost. In the period below, which of the components in the cost of merchandise sold calculation would be affected by a current period change in inventory valuation method (i.e. switching from LIFO to FIFO)?

FIFO Inventory Calculation

Compute the FIFO layers amounts for the cost of merchandise available for sale after each purchase and sale.

After 1/14 Sale

After 1/22 Purchase

After 1/25 Sale

Inventory and Cost of Merchandise Sold

Asset valuation and income measurement are two of the most fundamental accounting concepts. For any company that sells goods, inventory is a main focus. This problem concentrates on perpetual LIFO inventory valuation.

When a company records a sale, it is displayed on the   _________________   as   _________________   . The amount at which sold inventory is expensed depends on the   _________________   . The inventory remaining must be properly valued so that it can be reported on the   _________________   in the   _________________   section.

In order to determine the amounts to be reported on the balance sheet and income statement, you must first understand the relationship between the cost of merchandise sold and ending inventory. This relationship is expressed in the cost of merchandise sold model.

Use the selection lists to build the cost of merchandise sold model.

Inventory Systems and Costing Methods

There are two concepts that must be understood for inventory valuation and measurement: inventory systems and inventory costing methods. The two basic systems of accounting for merchandise inventory are the perpetual inventory system and the periodic inventory system. Under the   _________________   inventory system, continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold. Under the   _________________   inventory system, the inventory not yet sold, or on hand, is counted periodically. This physical count is usually taken at the end of the accounting period.

Although it is more expensive to maintain, the   _________________   system is far more accurate and up-to-date than other inventory tracking systems.

"Goods Flow" versus "Cost Flow"

LIFO (Last-in, First-out) Costing

There are four costing methods: specific identification; first-in, first-out (FIFO); last-in, first-out (LIFO); and average cost. This example will focus on LIFO. Under the last-in, first-out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold and the ending inventory is made up of the earlier purchases.

To better understand the LIFO method, imagine that beginning inventory and each purchase is a separate layer. These layers determine the cost of goods available for sale. For each sale, start with the latest purchase and work backwards until you have accounted for the units sold.

Using LIFO, we assume the costs of the   _________________   items we purchased are assigned to the first items we sell. Therefore, the most recent costs are assigned to the   _________________   while the   _________________   will consists of costs the beginning inventory and earlier purchases.

APPLY THE CONCEPTS: LIFO inventory calculation

Below is the data for the month of January, 2011.

Compute the LIFO layers amounts for the cost of merchandise available for sale after each purchase and sale.

After 1/8 Purchase

After 1/14 Sale

After 1/22 Purchase

After 1/25 Sale

Based on your answers above, complete the worksheet below.

b.  Based upon the preceding data, would you expect the inventory to be higher or lower using the last-in, first-out method?
  _________________